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Should You Prepay Your State And Local Taxes By Dec. 31, 2012?

Whether to prepay state and local taxes is one of the routine year-end question tax pros get, but this year, in the midst of stalled fiscal cliff negotiations, the answer isn’t clear for many taxpayers. “People are trying to decide what to do, but it’s hard to plan given a moving target,” says Thomas Savino, a CPA with Bonnano, Savino & Davies in Needham, Mass.

By state and local taxes, we’re talking about state and local income taxes, real estate taxes for your home, and personal property taxes (for cars and boats in some states). You get to deduct your state and local taxes on your federal tax return.

Normally, common advice is for people to prepay state and local taxes if it’s going to help them lower their federal taxes in the current year. That would mean accelerating payments due in January or even April 2013 into the 2012 calendar year, so you can take the deduction off your 2012 tax return.

However, prosperous taxpayers face higher rates come Jan. 1–just how prosperous is still to be determined. So the new common advice is to hold off on payments until the New Year. By postponing payments and the accompanying deductions until 2013, these folks should benefit because deductions are worth more if you’re in a higher tax bracket.

But what about the noise about limiting itemized deductions, including the deduction for state and local taxes? You have to weigh the chance that Congress will limit itemized deductions.

“Some people are saying, ‘I’d rather get the deduction today in hand,’” Savino says. They are accelerating income and deductions into 2012. “They’re gambling that Congress wants to do something to improve the fiscal situation, and limitations on itemized deductions are clearly on the table,” he says.

One caution for folks who are accelerating deductions into 2012: Run the numbers and make sure it doesn’t throw you into the alternative minimum tax. The AMT eliminates certain itemized deductions, including the deduction for state and local income taxes. Savino says he has clients who are on the cusp of AMT who maximize the state and local deduction just until the AMT equals the regular income tax. “After that there is no advantage,” he says.

If you know you’re always in the AMT, the answer is obvious: don’t accelerate state and local tax payments into 2012 because you won’t get to deduct them anyway. Savino’s wishful thinking: “You might as well hold on to that tax deduction in your pocket and hope that you may be able to take advantage of it in the following year.”

One more wrinkle: a whole lot more people–32 million, up from 4 million–will be in the AMT in 2012 unless Congress extends a temporary fix or “patch” to the AMT. But given the Internal Revenue Commissioner’s latest dire warnings about how the lack of a patch will prevent up to 100 million or two-thirds of taxpayers from filing returns at the start of the year, delaying refunds, one can only hope that Congress will put in a fix.

Check out the states where the AMT is most likely to hit your pocketbook.

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